Merkel's 'Austerity,' Obama's 'Growth,' and the Power of Framing

The media's coverage of the European debt crisis wrongly presents austerity in a negative light.

German Chancellor Angela Merkel
German Chancellor Angela Merkel in Chicago, Ill.

James Rickards is a hedge fund manager in New York City and the author of "Currency Wars: The Making of the Next Global Crisis" from Portfolio/Penguin. @JamesGRickards

Economic analysis is difficult enough without politicians misleading the public through something called "framing." The idea is that if your give your policy a good label and give your opponent's policy a bad label, those labels will stick and affect the debate even if the actual policies are the opposite of what the label tries to convey. This process has been given a boost lately with the popularity of behavioral economics, which looks at framing in a scientific way. Yet, it's one of the oldest tricks in politics.

One famous example is V.I. Lenin's propaganda stunt at a 1903 Socialist Congress. Lenin's group started out as a minority, but he gave it the name "Bolshevik" which means majority. He then labeled the majority party the "Mensheviks" which means minority. By switching the labels, Lenin gained support and eventually became the majority party and drove his opponents out of politics. Lenin's propaganda became a self-fulfilling prophecy. Such is the power of framing.

Something similar is going on in economics with the policy struggle between President Obama and German Chancellor Angela Merkel on the subject of how to rescue Europe from its sovereign debt crisis. Media coverage and political commentary have been dominated by the idea that Obama favors "progrowth" policies while Merkel is described as the champion of "austerity."

[See a collection of political cartoons on the European debt crisis.]

Once you frame the issue as growth versus austerity, the debate is over before it begins. Growth is as American as apple pie and is desired by every country in the world. Austerity suggests life in an unheated, cold-water flat. One half-expects Angela Merkel to show up at the G20 summit in a sackcloth and ashes. She is framed as the unenlightened villain in a policy set piece stubbornly refusing to see the wisdom of Obama's progrowth agenda.

Yet, once we peel the policy onion we see a propaganda exercise no less audacious than Lenin's original masterpiece. When Obama says "growth" he refers to a standard neo-Keynesian mix of fiscal deficits and money printing designed to stimulate domestic consumption by revving up the lending and spending machine one more time. Never mind that Obama's fiscal stimulus plan in 2009 failed to produce the promised jobs or that the U.S. debt-to-GDP ratio is at an all time high or that the Federal Reserve's $2 trillion in money printing has produced the weakest economic recovery on record. These failures in the United States have not dissuaded U.S. policymakers from trying to foist the same dreary and self-destructive package on Germany. Angela Merkel is wise to reject this Keynesian snake oil.

[See a collection of political cartoons on the budget and deficit.]

Meanwhile, a closer look at Merkel's so-called austerity policy reveals a solid and feasible plan to put Europe on a path of non-inflationary growth and fiscal stability. Merkel understands that the entire European sovereign debt load does not have to be paid off at once. All that is required is a credible plan to start moving in the right direction. Once the process commences, markets will give Europe the benefit of a doubt and begin to purchase their bonds at progressively lower yields thus creating a virtuous circle of debt discipline and lower interest costs.

Merkel also plans to meet Greece, Spain, and Portugal part way by allowing German unit labor costs to rise slightly as costs in the periphery decline so that the entire burden of internal adjustment is not put on the periphery. To do this, Merkel will allow higher than usual inflation in Germany. She can justify this by pointing to European-wide metrics. The combination of deflation in Spain and inflation in Germany will produce something like price stability when viewed from the perspective of Europe as a whole.

[See pictures of the EU in crisis.]

The final ingredients in this policy broth include European Central Bank rate cuts coming after the Greek elections in mid-June. Once Greece forms a government and steps up to its responsibilities under the European fiscal treaty, the bank can implement the cuts and the way will then be clear for International Monetary Fund and Chinese capital to help reliquify Europe. The goal is to combine available youth labor, lower unit labor costs, European Central Bank rate cuts, Chinese capital, and German technology backed by a favorable business climate to spark an investment-and-export driven renaissance in Europe as a whole.

Meanwhile, back in the United States, another broth of higher taxes, higher inflation, higher deficits, money printing, inflation and an uncertain and hostile business environment will insure below-par growth as far as the eye can see.

With proper framing, the Obama plan would be called reckless and the Merkel plan would be called prudent or visionary. Until then, we'll have to make do with the old frames. Hopefully better-informed citizens will see right through them.

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